Annual Proxy Considerations in the Area of Executive Compensation

Annual Proxy Considerations in the Area of Executive Compensation

September 20 2013

Picture1Preparing to file an annual proxy statement raises many questions for HR teams, executives, and directors, particularly compensation committee members.  As a concise summary, this chart addresses some of the more common and significant questions raised in this process for a larger NYSE- or NASDAQ-listed company.  We have provided general explanations and considerations to serve as helpful guidelines; however, the facts and circumstances of your company may warrant a different response and may change the result.  The terms in red are hyperlinks to additional information sources.

Equity Plans

  Explanation Follow-up / Considerations
Q: Must the equity plan be put up for shareholder action?
Yes, if a new plan or amendment provides for additional shares to be issued. Adopting a new plan or seeking additional shares under a plan amendment requires (with limited exceptions) shareholder approval under NYSE and NASDAQ rules and for favorable tax treatment.  Explain how the board determined the number of new or additional shares to be authorized.  Quantify total shares to be reserved under all equity plans. 8-K must be filed within four business days of shareholder vote.  Need new Form S-8 to cover new shares (cannot amend S-8 to add shares).  Confirm company has enough shares authorized under certificate of incorporation.
Yes, if materially amended. A “material revision” as defined by NYSE and NASDAQ, includes, but is not limited to: an increase in the shares available (see above); an expansion of types of awards that may be granted; expansion of eligible participants in the plan; and/or changes to material 162(m) terms, including per-person limits, eligibility and performance goals. 8-K must be filed within four business days of shareholder approval.  Consider whether submitting an amended and restated plan for shareholder approval (instead of individual amendments) is advisable or necessary.
Yes, if 162(m) re-approval is required. The majority of equity plans have been drafted to provide maximum flexibility; therefore, re-approval of material 162(m) terms every five years is likely required to avoid limits on tax deductibility.  This requirement also applies to some cash incentive plans; however, stock options, SARs and incentive plans that include funding formulas do not need five-year re-approval. 8-K must be filed within four business days of shareholder approval.
Q: Must the equity plan be described in detail?
Yes, if the plan or amendment is up for shareholder action. Provide a “fair summary” of the plan.  Remember to include: number of eligible participants; recent stock price; amendments permissible without shareholder approval that may raise costs; potential limitation on company tax deductions; new plan benefits table if an award was made that cannot be delivered without shareholder approval; and for 162(m) approval, a statement that plan and/or awards will be canceled if shareholders fail to approve. Plaintiffs’ firms are filings class actions challenging adequacy of proxy disclosures in connection with equity plans up for shareholder approval.  See Knee v. Brocade where court issued preliminary injunction delaying annual meeting.  On the other hand, in a number of cases, including in both CA and NY, preliminary injunctions have been denied where the court found that the additional disclosure requested was not material.
Q: Is the Equity Compensation Plan Information Table required?
Yes, if the plan is up for shareholder action. This table may be in either the Form 10-K or the Proxy (typically in the Form 10-K); however, it must be in the Proxy when a plan is up for shareholder approval.  Carefully review the table and footnotes against Item 201(d) of Regulation S-K; this information, significant for shareholder voting decisions, is often left out. See explanation above.  In Knee v. Brocade, Brocade filed supplemental proxy disclosure about potential dilutive impact of plan and proposal was passed by shareholders once meeting was held.
Q: Must an equity plan always be approved by shareholders?
No, but there are only limited exceptions to shareholder approval. Limited exceptions to shareholder approval include, but are not limited to: qualified plans; new hire inducement awards; certain plans in the context of a merger; and plans allowing purchase (or deferral equivalent to a purchase) of shares for full market value.  Inducement grants may only be made if approved by independent compensation committee or majority of independent directors. Plan must be filed with Form 10-K/10-Q.  If not covered by Form S-8, must disclose offers/sales in Form 10-K/10-Q.  When relying on these exceptions, a press release and/or written notice to the exchange may be required.
Q: Does the equity plan need to be 162(m) compliant?
No, but be aware of, and ready to disclose, intentional non-compliance. A few compliance areas to consider: (i) are equity awards in Grants of Plan-Based Awards (GOPBA) table within overall plan limits; (ii) are equity awards in GOPBA table within 162(m) per-person limits; (iii) are maximum annual incentives in GOPBA table within plan 162(m) limits; (iv) were the performance goals set early enough in the performance period; and (v) do the compensation committee members meet the applicable exchange, IRS and/or SEC requirements? Consider whether directors serving on committee are: (i) independent under the NYSE or NASDAQ standards; (ii) outside directors under 162(m); and (iii) non-employee directors under Rule 16b-3.

CD&A and Compensation – Related Disclosure

 

Explanation

Follow-up / Considerations

Q: Is an executive summary critical to the CD&A disclosure?
Yes, show how the pay program is reasonable and effective. This overview should include the “good” and “bad” information that would impact a shareholder’s interpretation of the executive compensation program.  Be sure to show how company performance and performance-based pay are aligned. Consider use of bulleted lists and graphics wherever possible.  Clear, easily understood, sufficient disclosure is an important tool to help avoid shareholder actions against the company.
Q: Do all performance metrics and targets need to be disclosed?
No, but they should be disclosed for completed years. Disclose material quantitative/objective metrics and targets for completed performance periods (targets for qualitative/subjective metrics (e.g., leadership) not needed).  Describe why such metrics were selected.  Disclose performance criteria for awards covering current and future years, but performance levels can be withheld if they are sensitive or could be misinterpreted as “guidance.” In an effort to avoid shareholder claims that the disclosure is inadequate, be sure to fully describe the metrics and targets.
Q: Is the 162(m) disclosure required in the CD&A?
Yes, 162(m) disclosure should be provided, but degree of disclosure varies. Disclose all material information relating to effect of 162(m).  While disclosing the specific lost 162(m) tax deduction(s) is not required, address the types of non-deductible compensation being paid if it represents a significant amount of Named Executive Officer (NEO)’s total compensation.  As a quick check, look at NEOs (excluding CFO) W-2s for taxable income levels above $1 million. Avoid boilerplate language.  Carefully choose words such as, “intended to”/”designed to”/”should”.  Plaintiffs class action lawsuits are claiming disclosure inaccurate and insufficient, such as performance goals applicable to incentive plan awards.  See Resnik v Woertz.
Q: Is disclosure on clawback policies required?
Yes, this is the type of disclosure that should be included. While not specifically required by name, clawback policies are material program terms that should be included in the CD&A.  Clawbacks may appear in a number of places (plan documents, award agreements, employment agreements, severance plans).  Check disclosure against all relevant provisions to ensure accuracy. Given the class action lawsuits on inaccurate or misleading disclosure, pay close attention to accuracy of clawback description(s).
Q: Must non-GAAP financial measures be further explained?
Yes, explain how non-GAAP numbers were calculated. Disclose how a non-GAAP measure is calculated from company’s audited financial statements.  CD&A disclosure of non-GAAP target financial measures are not subject to Reg G/Item 10(e), so a full reconciliation is not required.  Clearly label non-GAAP measures to avoid confusion and fraud claims. In addition to explaining how non-GAAP numbers were calculated, such numbers must be reconciled with GAAP numbers when used outside of the CD&A and compensation-related tables.
Q: Must the company disclose changes to the compensation program that are effective only after the fiscal year end?
Yes, if material changes were made to the program. The SEC has stated that this disclosure must be included.  Material changes could include the adoption of new or modified programs or other changes that might affect an investor’s fair understanding of the NEO’s compensation of the last fiscal year. While required if material changes have occurred, it appears that this is not currently a focus for SEC comments or shareholder advisory groups.  In practice, companies are disclosing shareholder-friendly changes to the program to get more favorable Say-on-Pay votes.
Q: Must the company disclose if the compensation program encourages risk?
Yes, disclose the results of such a risk review. Disclosure is required if risks arising from compensation practices are reasonably likely to have a material adverse effect on the company, including with respect to NEOs and non-executive officers, as they relate to risk management practices and risk-taking incentives.  In practice, if this were the case, the company needs to change the program. While not required, in Regulation S-K C&DI Q&A 128.01 the SEC has indicated that results of risk review should be included regardless of findings and should be included in the company’s annual proxy.

Compensation Consultant

 

Explanation

Follow-up / Considerations

Q: Must the company disclose the consultant’s role in setting compensation?
Yes, disclose retention of compensation consultant and role. Describe consultant’s role in determining/recommending amount/form of compensation and describe nature and scope of assignment.  Include material elements of instructions/directions given to consultants with respect to their duties under the engagement.  Disclose additional non-executive compensation consulting services provided to committee/company and disclose if fees for such service exceed $120,000. The proxy enhancement release has been interpreted by many to suggest that CD&A disclosure need not address management’s consultant if the committee has engaged its own consultant.
Q: Must the company disclose if the consultant had a conflict of interest?
Yes, disclose any conflict of interest and how it is being addressed. In considering whether a conflict exists, evaluate among other things the six-factor test for assessing independence of a compensation adviser.  A conflict review should be included for management’s consultant where the committee has not retained its own consultant. While not required, we recommend that this disclosure be included annually (even if no conflict is found) and that written records of this assessment be retained.  This disclosure is technically only required in a year when a director is up for election.
Q: Must information on management’s compensation consultant be included?
Likely not, if compensation committee retains consultant. Information on management’s compensation consultant must be included if the Board or compensation committee has not retained its own consultant. Given a company’s particular circumstances, consider evaluating and disclosing whether management’s consultant has a conflict of interest.
Q: Must information on the compensation committee’s assessment of each compensation advisor’s independence be disclosed?
No. The requirement that the compensation committee assess the independence of each compensation advisor (not limited only to compensation consultants) does not include a disclosure requirement. The SEC has reiterated, albeit informally, that such disclosure need not be provided.  Note that “compensation advisor” is a broader category that includes a compensation consultant.

Say-on-Pay, Say-on-Frequency

 

Explanation

Follow-up / Considerations

Q: Is annual Say-on-Pay vote necessary?
Yes, if the company made such election. The Say-on-Pay vote is a non-binding advisory vote.  The Say-on-Pay vote relates to the executive compensation disclosure included in the proxy (CD&A and tables).  The resolution can be very simple and refer to the disclosure in the proxy. Form 8-K must be filed within four business days of vote.  Accurate and timely disclosure is critical to regulatory compliance.  Some companies have the vote every two or three years.
Q: How often must a Say-on-Frequency vote be held?
Vote must be held every six years. Shareholders must be given option of a Say-on-Pay vote every one, two or three years or to abstain from voting.  The vote must be held at the annual or other meeting in the sixth calendar year after the immediately preceding Say-on-Frequency vote.  As a non-regular proxy voting item, this will be easy to overlook. Form 8-K must be filed within four business days of vote and amended within 150 days to disclose the company’s decision on frequency.  Failure to file this amendment in a timely manner may result in loss of eligibility to file registration statements on Form S-3.
Q: Must the proxy address the prior Say-on-Pay results?
Yes, address how the prior year’s Say-on-Pay results were considered. Include a discussion as to whether and, if so, how, the company considered the results of the Say-on-Pay vote in determining compensation policies/decisions and how that affected the company’s executive compensation decisions and policies. Even after a favorable Say-on-Pay vote, respond to shareholders’ concerns and emphasize this in disclosure.  ISS and Glass Lewis give additional scrutiny of companies that received < 70-75% votes in favor of prior year’s Say-on-Pay.

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